Latvias finance minister has defended his
governments decision to apply for eurozone membership,
saying in mid-March the single currency was much
stronger than before the financial crisis.

The debt crises in eurozone member states and the
market reaction to them have prompted a long-overdue policy
action to strengthen the coordination of fiscal policy and
accelerate reforms, Andris Vilks tells Euromoney.

Latvias decision came as
Lithuania announced in February that it is targeting
adoption in January 2015.
Poland also recently reiterated its commitment to the
single currency, although without setting a date for the
transition.

The timing of Latvias application to the European
Commission raised eyebrows, coming just one week after the
single currency wobbled because of the Italian election results
 and shortly before the
Cypriot crisis intensified. Still, speaking on March 14,
Vilks insists doubts on the euros viability had been
convincingly dispelled by the recent actions of
eurozone policymakers.

The decision of the European Central Bank to emerge as
lender of last resort has greatly reduced the risk of potential
break-ups, while the adoption of the fiscal compact has ensured
that fiscal policy in the euro area will be conducted in a
clear, counter-cyclical framework, he says.

Euro peg

The lat has been tightly pegged to the euro since May 2005,
when Latvia joined the ERM II. Double-digit inflation in the
run-up to the financial crisis prevented early adoption of the
single currency.

The bursting of a real estate bubble then plunged the Baltic
state into a deep recession:
the economy shrank by 17.7% in 2009. Under prime minister
Valdis Dombrovskis, however, Latvia has staged a recovery with
a stringent programme of front-loaded austerity measures.

GDP growth has averaged 5.5% over the past two years,
putting Latvia at the top of EU rankings. Growth of around 3.5%
is forecast for 2013. Meanwhile, average annual inflation has
stabilized around 2%. The budget deficit for 2012 was 1.5% of
GDP and debt-to-GDP ended the year at 42%.

Those metrics put Latvia comfortably within the Maastricht
criteria for euro adoption, and most analysts expect the
European Commission to recommend Latvia for membership when it
reports on its application by early June.

If the ECs assessment is positive, the recommendation
will then be put to the Council of Ministers, which could
ratify the decision as early as July  paving the way for
Latvia to adopt the euro on January 1 2014.

That means a relatively short timeframe for the Latvian
government to convince a sceptical public  only 36% of
which supports euro adoption  of the benefits of the
single currency.

Vilks says popular worries had faded, partly thanks to the
precedent set by Estonia, which adopted the euro in January
2011. He admits the government has to reassure Latvians of the
situation in the eurozone periphery but insists a recently
launched PR campaign could convince Latvians the worst of
the crisis is over.

According to a Eurobarometer survey published in April 2012,
Latvians were more concerned than the citizens of any other
potential eurozone member about loss of national identity, loss
of control over national finances and abusive price setting
during the transition to the euro.

Nevertheless, Vilks says he is confident Latvians can be
persuaded that the benefits in the event of further economic
disruption will justify the costs of joining the European
Stability Mechanism, estimated at 220 million over five
years. We view our contributions as equivalent to buying
an insurance policy, he says.

Plea of mitigation

Vilks says a key part of the governments message will
be that euro membership would have mitigated the effects of the
global downturn in Latvia. We would definitely have seen
a less severe contraction of the economy, lower unemployment,
lower emigration and more financial sector stability,
says Vilks.

That verdict seemed to be endorsed by the ratings agencies:
the day after Vilks spoke to Euromoney, Moodys upgraded
Latvia one notch to Baa2. It cited Latvias application to
join the euro area as one of the key factors in maintaining a
positive outlook on the sovereign.

Vilks adds that the pro-euro campaign would stress that
Latvia is already effectively using the single currency, thanks
to the currency peg, but without benefiting from the
eurozones support mechanisms or having a say in shaping
monetary policy.

Eurozone membership would have provided vital
liquidity shock absorption to the Latvian banking sector via
access to the ECBs support instruments, which could in
turn have avoided the need to bail out the largest domestically
owned bank [Parex Banka]. With euro adoption we will finally be
able to have an impact on issues that are crucial for our
economy, he says.

Further reading on Euromoney

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